Repeal will hit gasline, treasury

Post date:

Wed, 08/13/2014 - 9:05am

State administration officials are mulling a series of complex effects that a repeal of Senate Bill 21, should it occur on Aug. 19, would have on near-term state finances and the planning for the large natural gas pipeline project that is now underway.

“ACES will cause the oil tax rates to move up and down and when we add gas production to the equation, it can drag down the tax rate considerably under the progressivity formula in the ACES law,” Balash said.

Pawlowski said a return to ACES could undercut the state’s benefits for being in the gas project partnership, and would immediately affect the state’s effort to market its share of LNG.

“There would be a lot of unknowns for us, and this would occur just as we are beginning efforts to market our state share of LNG. This would cloud that, and in effect delay our marketing,” he said.

If voters opt to repeal the oil tax reform bill in the primary election Aug 19, the previous oil tax law, known as ACES, becomes effective relatively quickly, 30 days after the primary election results are certified.

This would have an immediate impact on state revenues in that a 20 percent capital investment tax credit, repealed under SB 21, would become effective again.

The effect on the state’s bottom line is complex, though, because a per-barrel production tax credit under SB 21 would be repealed. The per-barrel tax credit would have been in effect for several months of 2014, so in the end the 20 percent tax credit restoration may have the greater impact.

This tax credit means that 20 percent of several hundred millions dollars worth of industry capital spending made for the rest of the fiscal year — including the billion-dollar CD-5 oil project and the $4 billion Point Thomson gas project — would be deducted dollar-for-dollar from tax payments.

Because most construction on the North Slope occurs in the winter, capital expenditures made in November and December and the first four months of 2015, when a lot of work will be underway, would be eligible for the 20 percent credit against taxes in the current fiscal year.

The Point Thomson impact could be particularly severe. With ACES back in effect and big parts of this $4 billion project to be built in 2014 and 2015, the hit on the state budget could be several hundred million dollars.

Under ACES, a 20 percent tax credit on Point Thomson’s $4 billion cost would amount to $800 million paid by the state. This would be mitigated by the months that SB 21 would be in effect — so the winter and summer 2014 spending would not receive the credit — but project investments from November on would be eligible.

Aside from these effects there are also the producers’ deductions for lease expenses, both capital and operating, in the net revenues tax calculation, which could also affect state revenues adversely.

ACES has a base tax rate that is lower than SB 21 (25 percent vs. 35 percent), so the deduction of lease expenditures from the net value calculation even at the base rate will have a greater impact on revenues under ACES than SB 21.

ACES also has a “progressivity” formula, repealed in SB 21, that adjusts tax rates when oil values rise (the taxable value of oil per barrel is determined by oil prices as well as oil production costs).

However, under current prices and costs, even the progressivity formula, which raises tax rates by 0.4 percent for every $1 increase in oil value, does not offset the adverse effect on revenues caused by the lower 25 percent base tax rate.

A sample calculation demonstrates this: A $105 per barrel oil price minus $10 per barrel pipeline and tanker deduction leaves a gross value of oil on the North Slope of $95 per barrel. Fifty dollars per barrel could be deducted from this for production costs (assuming $30 per barrel for capital expenses and $20 per barrel for operating costs) to create a net taxable value of $45 per barrel.

Under ACES, the progressivity formula is applied when oil values exceed $30 per barrel. The application of the formula (0.4 percent per $1 increase above $30) amounts to a 6 percent addition to the 25 percent ACES base rate, or a 31 percent tax rate.

This is 4 percent lower than the 35 percent base tax rate under SB 21.

These effects — the capital investment tax credit and the lease expenses deduction — would not occur if the referendum is defeated Aug. 19 and SB 21 is retained.

Budget, gasline impacts

If SB 21 is repealed, it’s difficult to predict the effects on state revenues and the budget.

The near-term hit to state revenues caused by an ACES restoration will be softened, near-term, by the surge of new oil production that has resulted from the industry’s hefty investments over the past year, some of which occurred because of SB 21, the companies say.

There was no decline in oil production from the North Slope in fiscal year 2014, which ended June 30. Production averaged 531,000 barrels per day, up from an estimate of 508,000 barrels per day for fiscal year 2014 made in the December 2013 Revenue Department estimate.

How all of this might play out is highly uncertain. The hit to production tax revenues because of ACES would be offset by higher oil production, which will increase tax collections as well as royalty revenues.

An estimate would become available in late November or early December when the Department of Revenue does its next state revenue and oil production forecast.

There are other forces at work that could affect state oil revenues, too. A gradual decline in North Slope oil prices that has been underway for some time will also affect the net tax calculation, although that would occur either under ACES or SB 21.

Oil from the Slope has been selling at about $103 per barrel in recent weeks, down from $110 per barrel in early July. Some oil analysts believe increased shipments by rail of shale oil from North Dakota may be undermining oil prices on the west coast, where North Slope oil is sold.

Meanwhile, if SB 21 is repealed there would also be complex tax effects on the gas pipeline and additional reductions of state revenues, but those wouldn’t occur unless the project moves forward. The producing companies have said that is problematic under an ACES scenario.

The producers have said a return to ACES would inject volatility and uncertainty back into the state’s tax system because North Slope oil and gas production are interrelated (most of the gas would come out of the same wells that produce oil).

Fundamentally, the economics of future oil production, reinforced by SB 21, would helps sustain production because oil pays for the production infrastructure maintenance, the producers have said.

Gas production will not have the kind of margins needed to make much of a contribution to infrastructure support, they have said.

This aside, however, state officials are also looking at tax effects on gas under an ACES return. These could additionally undercut state revenues, and therefore undermine the benefits of the state’s participation in the gas project.

Under the current gas project plan the state will be a partner with industry in the project.

Here’s how this scenario could come about, officials said:

There will be additional capital investment tax credits for “upstream” investments for gas production. These would not include the gas pipeline or the big gas treatment plant, but they would include future capital investments for gas production at Point Thomson beyond the $4 billion now planned as well as certain investments for gas needed at Prudhoe Bay.

Using the example cited above of how an ACES return could immediately affect the taxable value of oil revenues — when the lease expenditures for gas production are added to the per-barrel taxable value calculation it would also have the effect of lowering the per-barrel value, and therefore the tax receipts.

Under Senate Bill 138, the bill passed by the Legislature last spring authorizing the state’s participation in the gas project (and which is unaffected by a potential SB 21 repeal), all gas production costs are deducted in the net-value calculated for oil because the state will take its tax share for gas in-kind, in the form of gas.

However, because of the progressivity formula, the effect of the additional gas costs on oil revenues would be greater under ACES.

Again, using the example cited above and assuming the same oil values and costs but adding $3 per barrel of oil equivalent for the gas production cost, the progressivity formula would cause the tax paid per barrel to decline $1.43 per barrel and lower the ACES tax rate for oil from 31 percent to 29.8 percent.

The gas production cost would also reduce oil revenues under SB 21 but by less, because the base tax rate is higher, at 35 percent, without a progressivity adjustment.

The effect under SB 21 would be to lower the tax liability, or tax paid, by $1.05 per barrel compared with lowering it by $1.43 per barrel under ACES.

If the gas production cost is higher, for example $5 per barrel of oil equivalent, these effects would be greater. In a $5-per barrel case, the tax paid would drop by $1.75 per barrel under SB 21 compared with $2.35 per barrel under ACES.

These effects would be on tax payments prior to the start of major gas production, which is expected in 2024 if the gas project proceeds.

Blending revenues

There is one other problem in this mix, however. It is this:

The ACES tax law requires the market value for gas that is produced and sold is to be included, or “blended” along with oil in the net taxable value.

The blending of lower value gas with higher value oil brings down the per-barrel net taxable barrel, reducing the oil tax rate under ACES and impacting state revenues. Under SB 21, however, the blending of the gas and oil does not change the flat 35 percent tax rate, and state oil revenues are not adversely affected by the production of gas.

“ACES takes the higher value of oil and blends it with the lower value of gas. It dilutes the combined value of the oil and gas,” which diminishes tax revenue, explained Pawlowski.

There could be a conflict in state statutes, however. SB 138, passed by the Legislature last spring to authorize state participation in the gas project, also requires the gas value to be excluded.

If SB 21 is repealed there would be an apparent conflict between the ACES and SB 138 statutes, which would exist side-by-side in law, Balash pointed out.

The Legislature would solve this by amending the statute one way or the other, and that wouldn’t have to be done until 2022, when the provisions affecting gas production taxes in SB 138 come into effect. However, it is one more uncertainty.

Meanwhile, if an ACES return would hit the state treasury, wouldn’t the lower taxes also benefit industry?

Oil producers, speaking on background, said there are indeed scenarios where the industry would be better off. However, the volatility and uncertainty of ACES, which is highly sensitive to unpredictable oil prices, still makes them prefer SB 21 because its effects are easier to predict and to model.

ACES is complicated in a number of ways. First, the oil value calculation is done monthly (and tax returns must also be filed monthly) which means month-to-month variations in oil prices can have outsized effects.

Tom Williams, BP’s tax manager, told state legislators in a briefing that sharp oil price fluctuations in 2009 caused wild swings in the company’s monthly production tax rates, from 15 percent to more than 50 percent.

A second complication is that costs are also included in the month they are spent, which means that heavy expenses for a project built in winter are reported in those months. Trying to predict those combined effects and estimate a company’s tax liability, or the taxes to be paid on a single project, are virtually impossible under ACES.

Balash said the uncertainty this creates wipes out any benefit of the 20 percent capital investment tax credit in estimating the economic performance of a proposed new oil project. “It means that incentive has zero worth,” he said.

Oil producers agree with that.

“We’re used to paying high tax rates but we need them to be stable, and to know what they are,” one company representative said on background.